Why Silver Is Likely to Correct at 20%

by: Jersey Trader

Silver has had a phenomenal run over the last year more than doubling in price. However, I think that it is overextended and is likely to suffer a correction of at around 20%.

To get an idea about how overbought silver is, we can compare silver to its 200 day moving average. When we look at silver from this perspective, we can see that it is more than 40% above its 200 day moving average, a level that resulted in corrections in the past. These corrections have been sharp, with three of the last four resulting in a 20%+ decline, and the most recent occurrence resulting in a 10% decline. Given that the last time was only three months ago and the correction was smaller than earlier occurrences, I think the correction following the current overbought level is likely to be of a greater magnitude, closer to the prior 20% declines.

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In addition to silver being overbought in dollar terms, it also appears overbought in terms of gold. The silver/gold ratio has spiked upward and is now at its highest in over 25 years. Relative to its 200 day moving average, it is also at levels where gold subsequently outperformed silver by a wide margin.

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In conclusion, silver is overbought both in nominal terms and relative to gold. Based on past periods when silver was at similar overbought levels, we can expect a correction of at least 10%, but more likely in the 20% range. Owners of silver should consider selling some or switching to gold, while traders can consider buying the UltraShort Silver ETF (NYSEARCA:ZSL).

Disclosure: I am long DBP, GLTR.